Tuesday, 28 July 2015

Corruption in defence procurement: “Blacklisting” must remain an option

By Ajai Shukla

Business Standard, 28th July 15

The debate over whether it is wise to
blacklist global arms corporations found guilty of bribery and corruption is
gathering steam as the defence ministry finalises its forthcoming defence
procurement policy of 2015 (DPP-2015).

The National Democratic Alliance (NDA)
government has always believed that the blacklisting of arms vendors who
violated the DPP has become a stumbling block in defence procurement. Fifteen
companies are already blacklisted and another 23 are under defence ministry
scrutiny; the government cannot procure equipment of spares from them,
narrowing its procurement options.

On August 23, 2014 former defence minister,
Arun Jaitley, said corporate wrongdoing should be punished without blocking
acquisitions and the flow of spares.

“We have to balance between two competing
public interests. One public interest is that contracts are meant to be abided
with and not violated, even by our suppliers. The other competing interest is
the larger public interest in terms of our national security and defence
preparedness. It is an issue that we are fully seized of and we are in the
process of finding an answer to this, and you will hear about this from us very
soon”, he promised.

Jaitley was referring to the Italian
defence conglomerate, Finmeccanica, which the defence ministry had banned since
February 2013, along with its subsidiaries, many of which are key defence
suppliers to India. These include marine systems vendor, Whitehead Alenia
Sistemi Subacquel (WASS); radar and communications specialist Selex Electronics
Systems (ES); aerospace giant, Alenia Aeromacchi; armaments major, Otomelara;
and helicopter maker, AgustaWestland. The United Progressive Alliance (UPA)
defence minister, AK Antony proscribed Finmeccanica after its chairman was
arrested in Italy on charges of bribing Indian officials to win a contract for
twelve AgustaWestland AW-101 helicopters to ferry Indian VVIPs. The Italian
court has since dismissed the case, but a Central Bureau of Investigation probe
continues.

On August 26, Jaitley diluted the ban on
Finmeccanica, allowing India’s military to go ahead with contracts already
signed with its subsidiaries and to buy spares and upgrades for equipment
earlier procured. However, Finmeccanica group companies remained proscribed
from new tenders, and those where it was participating, but a winner had not
been announced.

Manohar Parrikar, who succeeded Jaitley as
as defence minister last November, shared Jaitley’s distaste for blacklisting.
On December 12, Parrikar declared that companies that violated procurement
norms should face “heavy financial penalties”, not blacklisting. Citing
Finmeccanica, Parrikar asked: “Should we rule ourselves out of dealing with all
of its 39 subsidiaries? There has to be a clear policy on that.”

Voicing his own views, Parrikar proposed:
“How much you (the vendor) violated, pay the Indian government 4-5 times that,
only then will you be permitted to participate in defence tenders.”

Calling this just “loud thinking”, Parrikar
promised a formal policy on representatives and blacklisting by January 2015.
The wait for this continues, with government legal experts and bureaucrats
unwilling to renounce a key lever in their enforcement toolbox.

With the ministry publicly advocating
out-of-court settlements rather than prosecuting of defaulters, the private
industry has pressed home the advantage. On Wednesday, the Confederation of
Indian Industries (CII), which represents big private sector corporations,
issued a briefing paper that proposed the adoption of US-style “deferred
prosecution agreements” (DPAs). In a DPA, the government grants amnesty to a
defaulting company in exchange for its cooperation in investigating violations,
hefty cash fines and an explicit or implicit acceptance of guilt.

Enumerating the disadvantages of
blacklisting, the CII says it could result in vendors deciding “the risk of
conducting business in India is too high”; dilution of competition in defence
procurement that is already a field with limited players; and, in some cases,
denying the military equipment that might be available only from a blacklisted
company.

The CII paper also warns against the
“Arthur Andersen effect” of blacklisting and vigorously prosecuting an erring
vendor. This refers to the collapse of the American accounting firm in 2002
after its prosecution for falsifying the accounts of Enron. That led to the
loss of about 28,000 jobs, many of them of innocents.

“[Blacklisting] has usually not served its
desired purpose. The inquiry is often delayed and moves in circles… (and) the
matter is stuck in the Indian legal system. On the other hand, the automatic
blacklisting of companies limits the government’s options of negotiating a
better deal from multiple supplier sources”, argues the CII paper.

It is true that none of the companies that
the defence ministry has blacklisted over the years have been successfully
prosecuted and penalised for wrongdoing. However, defence industry experts
overwhelmingly agree that this is not for lack of guilt, but rather because of
the weaknesses and complexity of India’s criminal prosecution system.

The DPA that the CII recommends traces its
roots back to 1992, when the US Department of Justice (DoJ) agreed not to
prosecute investment banker, Salomon Brothers in view of its “unprecedented
cooperation” with an on-going investigation. Later, the US formalised
guidelines for DPAs in the US Attorney’s Manual and other official procedures.

Legal expert, Percival Billimoria, says the
US DoJ offers a DPA when it believes the benefits of voluntary disclosure and
large restitution payments outweigh the benefits and uncertainties of
prosecuting the offending company. A DPA usually includes an acknowledgment by
the offending company of the offences it has committed; an obligation to
cooperate fully with the prosecuting/investigating agency; details of the
consequences of breaching the DPA; an acknowledgment that a repeat offence
would lead to prosecution; an agreement to institute internal compliance
mechanisms to prevent further breaches of law and ethics; and an enumeration of
penalties/fines imposed.

The CII states that $24.8 billion in fines
were imposed in the US during 2010-2014, of which $3.87 billion were for
violations of anti-corruption laws.

While there are clear advantages to
offering a DPA in certain cases, a growing school of thought warns against
allowing companies to buy their way out of trouble as a matter of course. The
DPA model, in fact, is facing growing criticism within the US, since it makes
adjudicating guilt the preserve of prosecutors, not courts of law.

Legal experts like Sherbir Panag, who heads
the criminal compliance practice of MzM Legal, point out that the multi-million
dollar fines imposed by the US DoJ and Securities Exchange Commission (SEC) ---
Siemens alone paid $800 million in one case --- in no way indicate that
criminal misconduct has reduced or compliance has become more robust. Reduction
in the commission of offences and behaviour alteration requires strong
deterrence induced by prosecution of individuals and companies. That is not
achieved if liability reduction paperwork replaces prosecution substantially.

“The corporations that bear the fines start
accepting them as an opportunity cost of doing business, unless sanctions and
penalties proportionate to the offences committed are imposed”, says Panag.

Furthermore, a DPA only becomes attractive
to a company if it is backed by a strong investigative and prosecuting mechanism,
which India clearly lacks.

“The US has a focused and centralised
agencies, centred on the DoJ and the SEC. In contrast, India has a plethora of
agencies, mostly working at cross-purposes: the defence ministry that orders
investigation and imposes the administrative sanctions; the Central Bureau of
Investigation; and numerous agencies investigating economic offences. Besides
having to coordinate these, major substantive and procedural law reforms would
be needed to allow DPAs”, points out Panag.

As the defence ministry grapples with these
shortcomings, it is evident that the airy imposition of monetary fines cannot
credibly replace criminal investigation and prosecution. Blacklisting must
remain in the sanctions/penal toolbox of the defence ministry, along with the
possibility of negotiated resolutions through DPAs. To be credible, both must
be backed up with vigorous investigation/prosecution mechanisms and a tailored
legislative framework.